Cascade: No. 81, Fall 2012

A professor who has followed the fiscal crisis, a manager of a bankrupt city, and a former mayor shared insights with a Reinventing Older Communities audience on how cities can best cope with financial problems that have worsened during the recession. Their overall recommendations were to:

set realistic expectations;

build trust with unions, businesses, and the public;

create balanced multiyear budgets; and

look for opportunities to make needed reforms.

Operate with Balanced Budgets

Robert Inman, professor of finance at the University of Pennsylvania and author of Making Cities Work: Prospects and Policies for Urban America, pointed out that some cities manage to do well in recessionary times. These cities tend to have a diversified private-sector economy, an educated and flexible workforce, and a rainy day cash fund with at least 5 percent of city expenditures. They also have the ability to reduce or contract-out staff and services and to refuse demands for services that don’t benefit all residents of the city.

Inman recommended that in difficult fiscal times cities ought to:

tax businesses and homeowners where they are located, rather than impose nonresident sales and wage taxes.

provide high-quality services and pay for value, not votes, basing wage increases on productivity gains rather than on an expectation of political support.

“run balanced budgets, not deficits.” Watchdogs such as the Pennsylvania Intergovernmental Cooperation Authority (PICA) provide valuable oversight of city finances.1,2

give businesses and homeowners choices, such as business and neighborhood improvement districts and school vouchers.

provide services for low-income residents, but finance these services at the regional, state, or federal levels.

From 2008 to 2011, state and local governments’ expenditures exceeded revenues by a cumulative deficit of $334 billion, said Inman.3 During these years, the states and cities underfunded pension liabilities and relied excessively on investment returns. These returns, Inman said, dropped from $532 billion in 2007 to $26 billion in 2010.

Credibility and Integrity

Phil Batchelor, a consultant who was hired as the city manager to lead Vallejo, CA, after it filed for bankruptcy protection in 2008, recalled that Vallejo’s expenditures exceeded revenues by more than $11 million in the three-year period prior to bankruptcy (see the figure). According to Batchelor, Vallejo’s labor contracts were marked by costly minimum staffing levels, unsustainable defined benefit pensions, and lifetime retiree medical coverage.

Following bankruptcy, Vallejo laid off 47 percent of the staff in the city’s police department and 42 percent of the staff in the fire department and eliminated all discretionary programs in the city, including funding for the library, a recreational district, and a wide range of community-based organizations.

In this difficult situation, Batchelor said the city met with the public employee unions and tried to keep a professional tone “in an environment of credibility and integrity.” As the city manager, he worked to create “a new culture” in the city employee workforce, met with and trained all city employees, and communicated regularly with employees on city decisions.

Batchelor explained that bankruptcy is “no easy answer” and is a “last-ditch alternative.” Entering into bankruptcy didn’t relieve Vallejo from its obligations to balance its budget, settle with claimants, reduce unfunded liabilities, and get its financial house in order.4 Bankruptcy-related legal fees were significant, totaling $12.5 million, he pointed out. According to Batchelor, many other cities are positioned to meet the same fate as Vallejo if they do not get their financial houses in order.

It may be difficult for cities to make reforms even in the face of fiscal problems. Although bankruptcy is generally to be avoided, it can be a political tool to advance reform, Inman pointed out.

Build Trust

Anthony Williams, who served as mayor of Washington, D.C., from 1999 to 2007, said that in difficult financial circumstances, it’s imperative that a mayor build trust with businesses, unions, and the public. Currently a senior strategic advisor and independent consultant with McKenna Long & Aldridge LLP, Williams said that the best thing a mayor can do is set realistic expectations for the city. The best mayors are good public managers and are respected, he added.

Williams advocated that cities maintain multiyear, transparent balanced budgets and said that a city’s chief financial officer ought to be an independent person who can carry the burden of making tough decisions. If an unpopular decision such as layoffs must be made, do it quickly, he recommended.

Cities can find opportunity in crisis, Williams said, and they can become a laboratory of experimentation and restructuring as they address financial problems. In a later discussion, Inman reiterated the importance of a climate of trust among the city, unions, and other sectors. “The real tough problems are solved by trust, not contracts,” he said.

* The views expressed here are those of the author and do not necessarily represent the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System.

1 PICA has approved 19 financial plans for Philadelphia, including a plan for fiscal years 2011–2015. See http://www.picapa.org/.

2 Inman said that he is working with Federal Reserve researchers on applying the PICA experience to develop a model for financial oversight of state and local governments.

3 The data source is the National Income and Product Accounts, Table 3.3, as revised on July 27, 2012. This measure of the state and local deficit includes federal grants-in-aid as revenue to state and local governments.

4 Vallejo’s bankruptcy plan provided for significant reductions in interest rates, maturity dates extended by 10 years, no interest accruals for four years, no payments for three years, and general fund savings that created a pool for unsecured general creditors, according to Batchelor.